War Will Not Deter This Market

 |  Includes: DIA, IWM, QQQ, SPY
by: Eric Parnell, CFA


News headlines have recently been filled with reports of mounting geopolitical conflict across many parts of the world.

Some of these conflicts have economic implications including the potential disruption of global oil and energy supplies.

But using history as a guide, stocks are unlikely to be deterred from advancing by these growing risks.

"Only the dead have seen the end of war"


News headlines have recently been filled with reports of mounting geopolitical conflict across many parts of the world. Hot spots have included the Ukraine and Russia, Iraq, China and Vietnam, Venezuela, Pakistan and Eastern Africa among many others. And some of these conflicts have economic implications including the potential disruption of global oil and energy supplies. Given all of the uncertainty associated these burgeoning conflicts, many are left wondering whether these developments will finally derail the relentless U.S. stock market advance. Using history as a guide, stocks are unlikely to be deterred from advancing by these growing risks.

Before going any further, it is important to provide a brief word on my overall view about today's markets. I have long been of the opinion that the U.S. stock market has extended well beyond what is reasonably implied by underlying economic and corporate fundamentals due in part to unnecessarily accommodative monetary policy and is exposed to the potential for a meaningful and prolonged bear market at some point going forward. The primary question at this stage is when the market will finally peak and begin to correct. But while the outbreak of geopolitical conflict, even if it directly involves the United States, might result in a short-term market correction at some point, it is unlikely to be the catalyst that starts the next major bear market.

The last century of stock market history has been filled with extended periods of war in many parts of the globe. And despite the associated social and economic uncertainty, stocks if anything have shown the tendency to not only survive but actually thrive during such times of global conflict.

The following are just a few of the many historical examples:

World War II

When the market closed on the Friday before the attack on Pearl Harbor, stocks were mired in an extended bear market. After peaking in March 1937, the Dow Jones Industrial Average had lost more than -42% of its value over the next four and a half years through early December 1941. And one could reasonably expect that a direct attack on the United States and the war that followed over the next several years would be the recipe to plunge stocks to extraordinary new depths. But while stocks did go on to decline by another -17% over the next few months, they actually bottomed only a few months after Pearl Harbor in April 1942. What followed over the next three and a half years was a sustained rally that saw stocks gain +87% and recover most of the losses sustained during the bear market that preceded it. It's worth noting that much of this advance took place long before the outcome of the war where the allied victory was far from certain.

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Cuban Missile Crisis

For two weeks in October 1962, the United States and the Soviet Union came precariously close to a full blown nuclear conflict. And despite the prospects for literal mutually assured destruction (unlike the financial variety that continues to overhang markets today), stock investors largely shrugged. The S&P 500 Index (NYSEARCA:SPY) did experience a fleeting -6.6% decline over the course of six trading days during the crisis, but by the start of November it was already higher than it was before the conflict. In short, the potential existed that the civilized world as we know it was at risk of coming to an end, yet the stock market only briefly declined by less than -7% and was completely over it all a mere five days after the conflict ended.

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Iran Hostage Crisis

On November 4, 1979, 66 American diplomats and citizens were taken hostage at the U.S. Embassy in Tehran. It was an episode that undermined the perceived strength of the United States on the global stage and stretched on for over a year until the hostages were finally released on January 20, 1981. But other than a brief correction from February to March 1980 that erased an early rally, stocks were meaningfully higher than they were at the start of the crisis.

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The Gulf War

On August 2, 1990, Iraq under the leadership of Saddam Hussein launched an invasion into neighboring Kuwait. A few months later on January 17, 1991, a coalition of forces from 34 countries led by the United States engaged in Operation Desert Storm in response to the Iraqi invasion. By February 28, 1991, Iraq was defeated and a ceasefire agreement was reached.

In regards to the markets, while stocks did decline by as much as -16% in the first couple of months following Iraq's invasion of Kuwait, the decline was fleeting and only represented a return to levels that represented post-1987 crash highs just a year earlier in April 1989. And stocks bounced convincingly higher following this otherwise short correction, as they regained all of their lost ground only days after the launch of Operation Desert Storm and were solidly above pre-conflict levels at fresh new all-time highs by the time the ceasefire was declared.

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9/11 Terrorist Attacks

If ever there was a test of stock market resilience during times of war, it was the terrorist attacks on September 11, 2001. Not only did the United States suddenly find itself at war with what was then a still unknown enemy, but the attacks were also targeted directly at the financial heart of the United States in New York City and the World Trade Center and resulted in a staggering number of casualties.

If ever there was a time when investors might be inclined to abandon from the stock market, this was it. Not only was the stock market itself closed for the first four trading days following the attack, but it came in the midst of a bear market that had begun over a year ago and had already taken the S&P 500 Index lower by -28% in the final day of trading on September 10 before the world changed the next day. But while the stock market did decline by -11.6% in its first week after reopening, it quickly regained its footing. It recovered all of the ground lost during the attack and more only three weeks later in mid October 2001 and was trading solidly higher as late as March 2002 before finally relenting to what were broader and fundamentally driven bear market forces that were mostly at work regardless of whether the terrorist attack took place or not.

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Iraq War

On March 20, 2003, the United States led an invasion of Iraq driven by the perception that the country under Saddam Hussein's leadership possessed weapons of mass destruction. The attack was taking place almost three years after the S&P 500 Index had peaked on March 24, 2000 and only days after the market made its latest attempt at testing support at the July 2002 and October 2002 lows (remember when stocks would behave rationally and actually show some hesitation by consolidating and testing support/resistance levels multiple times over the course of several months before reversing course? Those were good times.). Despite the uncertainty associated with the conflict, the outbreak of the Iraq War effectively represented the final bottom before the stock market entered into a more than four year cyclical bull market run that returned it to previous all-time highs.

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Bottom Line

The world seems to be embroiled in a fresh new geopolitical conflict with each passing day lately. And given the social and economic uncertainty associated with such events, it is understandable for market participants to wonder whether they will eventually have a direct and adverse impact on their portfolios. But while a short-term pullback lasting as long as a couple of months should not be ruled out, history has shown that stocks are surprisingly resilient and often end up rallying in the midst of military conflict, even if it includes the direct and active involvement of the United States. In short, this bull market will eventually come to an end, but it appears unlikely the catalyst will be the outbreak of war somewhere in the world.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long stocks via the SPLV and XLU as well as selected individuals stocks. I also hold a meaningful allocation to cash at the present time.